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S-Cool Revision Summary

S-Cool Revision Summary

A firm is allocatively efficient if it produces at the level of output where its price is equal to its marginal cost. For a whole economy to be allocatively efficient, this must occur in all markets.

Backward vertical integration

This is where a firm merges with another firm in the industry that is further back in the production process. For example, a car producing firm merging with a car parts factory.

Barriers to entry and exit

These are measures taken by firms, or factors that occur naturally, that prevent new firms from entering a given industry. Barriers to exit are, in themselves, barriers to entry, because a firm will not be keen to enter an industry if it knows it will be difficult to exit in the unfortunate circumstance that they make losses.

Cartel

An informal agreement between a group of firms in terms of setting output so as to maintain artificially high prices. This usually happens in oligopoly.

Ceteris paribus

This is a Latin phrase meaning 'all other things being equal'. It is used in economics because it would be difficult to assess the relationship between one variable and another without assuming that all other variables remain constant. It's a bit like having the 'control' in science experiments.

Collusion

Quite simply, this is where firms collude. They get together to make agreements about price and output. Firms do not like uncertainty, so collusion is a solution. The informal agreement between these firms is called a cartel. This usually happens in oligopoly.

Common Agricultural Policy (CAP)

This is a policy of the European Union and is similar to a Buffer stock scheme. The EU tries to protect the incomes of European farmers by offering various subsidies so as to protect them from the fierce competition from abroad. The EU does not want to find itself in a situation where it relies on other countries for all its food requirements.

Competition Commission

Used to be called the Monopolies and Mergers Commission. This is a body whose job is to make sure that the industries in the UK remain competitive. Their main job is to look into mergers and make sure that the combined entity does not become too big and powerful.

Concentration ratios

These ratios give you an idea of how concentrated an industry is. For example, if the largest four firms in an industry account for 80% of the market share, the industry would have a high concentration ratio.

Consumer sovereignty

If the consumer is sovereign, then the consumer is king! In a market where the consumer is sovereign, the consumer is in control. Only the products that the consumer wants are produced. The consumer uses his 'money votes' to let the producers know what he wants. The more competitive the market structure, the power the consumer will have.

Consumer surplus

This is the intangible benefit that consumers derive from the fact that the price some of them are willing and able to pay (represented by the demand curve) is higher that the price that they actually have to pay.

Contestable markets

The key characteristic of contestable markets is the fact that there are no barriers to entry or exit. Obviously, perfectly competitive and monopolistically competitive firms are, therefore, contestable. But this concept is more interestingly applied to certain oligopolistic markets, where there are only a few firms, but the franchise system used means that barriers are low and the incumbent firms are under constant pressure from potential competition (e.g. the railways)

Deadweight loss

This tends to refer to a loss to society as a result of allocative inefficiency. If you throw'deadweight' into a river it tends to be lost forever. So is the case with this welfare loss.

Duopoly

Monopoly is a market structure with only one firm. Duopoly is a market structure with only two firms. Collusion is likely so that the market effectively is very monopolistic.

Economies of scale

Quite simply, this refers to 'economies' made by firms or industries as a result of increasing in 'scale'. In other words, as a firm gets bigger, its average cost tends to fall because of things like bulk buying, specialisation and spreading administrative costs.

Factors of production

The four factors of production are land, labour, capital and entrepreneurship. They are the inputs into the production process.

Forward vertical integration

This is where a firm merges with another firm in the industry that is further forward in the production process. For example, a car producing firm merging with a car dealership.

Franchise

If the government grants a franchise to a firm for a period of, say, seven years, it means that the firm has been given the legal right to supply the good or service in question for the stated period of time. This sounds like a license to print money, but the potential competition from firms keen to join in should force the firm to keep profits relatively low. This is very closely linked to contestability. It is the lack of barriers to entry and exit that make the potential competition possible.

Homogenous

This literally means 'exactly the same'. In the context of market structure, the word is used to describe the product produced in the market. Perfectly competitive firms produce homogenous goods - all firms produce identical goods.

Inelastic demand

The demand for a good is relatively inelastic when, for a given percentage change in its price, the percentage change in the quantity demanded is smaller. Goods with very few substitutes tend to have relatively inelastic demand (e.g. petrol).

Kinked demand curve model

This is the model of oligopoly that suggests price stability. Each firm has a kink in its demand curve. Demand is elastic above the kink and inelastic below the kink. Hence, it is best if the firms in the industry do not raise or cut their prices, otherwise they will experience a fall in revenue.

Limit pricing

This often occurs in oligopoly. Existing firms try to prevent new firms from entering the industry by setting a price that is low enough to put newcomers off, but as high as possible given that constraint. Usually the price is quite low, but still high enough to make some sort of profit.

Market structure

The structure of a market can range from the most competitive, perfect competition, to the least competitive, monopoly. Other factors that affect the structure of a market include the number of buyers and sellers, the level of barriers to entry and exit, the extent to which the goods produced are similar and the extent to which all the firms in the market share the same knowledge.

Monopolistic competition

This is a market structure that has many similar assumptions to perfect competition. The main difference is that products can be differentiated. Along with the fact that, although there are numerous firms, the number is not infinite, this means that a firm's demand curve is very elastic (i.e. fairly flat), but not perfectly elastic (i.e. horizontal).

Monopoly

This is the least competitive form of market structure. A monopolist is the only firm in the industry, and so has total power. Monopolists tend to maximise profits to the detriment of efficiency.

Natural monopoly

An industry is known as a natural monopoly if the conditions 'naturally' point to monopoly being the market structure. In the electricity industry, for example, there is only one national grid. Due to thehuge costs of setting up the grid, it makes sense that only one firm (or the government) run the national grid. It is not efficient to have two national grids - it is a waste of resources.

Negative externalities

An externality is a sort of 'by-product' of a certain production process, or of consuming something, which affects a third party. Negative externalities are 'by-products' that impose costs on a third party. For example, pollution is an example of a negative by-product of a production process that will affect a third party (affluent pumped into a river that is used by fisherman, for example).

Non-price competition

A feature of oligopoly. Prices tend to be quite stable in oligopoly, so much of the competition is of a 'non-price' nature. Examples include advertising, quality and after-sales service.

Normal goods

Most goods are normal goods. If a good is normal it means that its demand will rise following a rise in real incomes, ceteris paribus (see the 'Elasticity's' topic for much more detail).

Normal profit

If a firm is earning normal profit, then average revenue = average cost. Effectively, it is breaking even. Although revenue only just covers cost, the total cost does include a payment for the owner as well as wages, so it is not as bad as it sounds!

Oligopoly

This is probably the most realistic market structure. Although the number of firms in the industry may be quite large, the industry will be dominated by a small number of large firms. Obviously, there will be barriers to entry. Firms are interdependent, and have to consider each other's actions. Prices tend to be fairly stable (perhaps due to the kinked demand curve model) sonon-price competition is very important.

Patent

This is one of many barriers to entry. A patent is something that is granted by the government that gives legal protection to an inventor to sell his new product without any competition for a few years.

Perfect competition

This is the most competitive form of market structure. Firms in perfect competition have numerous characteristics (see the topic of 'Market structure' for details). It is felt that this is the most efficient of all the market structures. Unfortunately, it is also the most unrealistic!

Perfectly elastic demand

If a good has perfectly elastic demand, then its demand curve is horizontal, implying that the demand for the good in question is infinite at the given market price. Sales will be zero if the price is raised, and there is no point reducing the price because the firm can sell as much as it wants at the given market price. This is an unusual situation that is only seen in the unrealistic theory of perfectly competitive markets.

Predatory pricing

As the title suggests, this is a pricing strategy used by firms to kill off other firms. The price is reduced to below cost price. The short-term loss is considered worthwhile if the result is fewer firms in the industry. Once the firm in question has been forced out of the industry, the price rises back to the original level and market share should increase.

Price differentiation

Not to be confused with price discrimination. Price differentiation is where the price charged to different consumers can differ, but only because the cost of production differs too.

Price discrimination

This is where a firm (with enough market power) charges different prices to different customers, even though the cost to the firm of each unit is the same. For example, phone calls are cheaper after 6pm, but the cost to the firm stays the same.

Price makers

The only true price maker is the monopolist. It is the only firm in the industry and so has full control over the price set.

Price takers

The only true price takers are perfectly competitive firms. There are so many firms in these industries that the actions of one firm have no effect on the market price. All firms in perfect competition have to 'take' the given market price. They have no control over the price they set.

Price wars

Another feature of oligopoly. This is where firms keep trying to out-do each other in the war for the customers' demand by continually reducing their prices. This is often seen in the market for petrol.

Privatisation

This is the transfer of assets of economic activity from the public to the private sector. Denationalisation is the form that most people understand (e.g. selling off gas or electricity), but it can include deregulation (the removal of legal barriers to entry in a previously protected market to allow private enterprise to compete) or franchising (where the government allows a private firm to run a previously state run activity for a given period of time).

Producer surplus

This is effectively profit. If a producer has a surplus over and above his costs, then he is making profit. Diagrammatically, it is the area above the supply curve, below the price and to the right of the y-axis.

Productive efficiency

A firm is productively efficient if is producing at a level of output where average costs are at a minimum. This occurs at the bottom of the average cost curve, where the marginal cost curve crosses.

Productivity

Productivity is the output per unit of input. Usually, labour is the input in question, so it is labour productivity that we are dealing with. This is output per unit of labour. Sometimes it is measures in terms of output per man-hour. Productivity can also be measured in terms of factor inputs or capital.

PSNCR

This stands for Public Sector Net Cash Requirement (formerly the PSBR, or Public Sector Borrowing Requirement). This is the amount that the government has to borrow in a given year as a result of government spending being higher than its revenue from taxation.

Regulatory capture

This was a common problem for the regulators of the privatised utilities. If an industry was privatised in one go (like gas, although competition has since been introduced), then the only way that regulators could get information about the industry was from this one private monopoly. Obviously, these private monopolies would only feed the regulators the information that they wanted them to hear. The regulators had been captured by the utilities.

Shut-down point

This is the point where the marginal cost curve cuts the average cost curve at its lowest point. In a perfectly competitive market, if a firm's revenue does not even cover its variable cost, then the firm must shut down, even in the short run.

Subsidies

These are payments made by the government to various firms to encourage them to set up in areas of high unemployment, or to continue producing essential goods. Farmers are given subsidies because they make important goods. A subsidy will shift a firm's supply curve to the right.

Sunk costs

Sunk costs are the unrecoverable costs of entering an industry. Advertising costs are a good example.

Super normal profit

This is any profit that a firm earns that is over and above normal profit (which is breaking even).

Vertical integration

This refers to the merger of two firms that are in the same industry but at different stages of production. Vertical integration can be forward or backward.